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Why oil prices will bounce back … eventually

ERIC REGULY – EUROPEAN BUREAU CHIEF

ROME — The Globe and Mail

Published Friday, Nov. 28 2014, 5:29 PM EST

Last updated Friday, Nov. 28 2014, 5:44 PM EST

When an asset class takes a swan dive off the cliff, fortunes can be lost trying to call the bottom. It’s often impossible to tell whether the asset in question is on a suicide run or undergoing a short-term correction. And so it is with oil.

Oil prices are down by a third since June and are less than half of their 2008 high of $147 (U.S.) a barrel. So time to buy? If I knew how to call bottoms, I would not be a miserable, ink-stained wretch; I would be filthy rich and living in a villa on the Amalfi Coast or Côte d’Azur, martini in each hand. But allow me to present four ideas of why the foundation for a compelling oil price bounce-back is being set even as prices tumble. I’m just not going to tell you when that might happen, because I have no clue.

The best cure for low prices is low prices.

In the late 1990s, oil, in nominal dollars, fell to $10 a barrel and the Economist famously predicted that $5 oil was coming, a call that, 25 years later, still haunts the magazine like an obsessed lover from your youth. Of course, the low price stimulated demand and drivers flooded into showrooms to buy rolling, gas-slurping pigs like Ford Explorers. At the same time, the low price choked off exploration and development, constraining supply.

By 2005, oil was at $60 and would more than double again before peaking out and crashing during the financial crisis – just as low prices cure themselves, so do high prices. We don’t know if the current price of $70 a barrel can be considered low, but we do know that prices in the $60-to-$70 range will hurt the high-cost producers, a group that would include the deep-well offshore operators, the oil sands and some of the short-life U.S. shale oil wells (Société Générale says the big American shale plays, such as the Bakken, need about $65 to keep pumping). As capital expenditure budgets get crunched – and they’re getting crunched now – supply will eventually fall. But that may not happen quickly because the big production projects that are already under construction can’t be cancelled or slimmed-down. But rest assured, it will happen.

Peak oil is real, depending on how you define oil.

Euan Mearns, an oil analyst I like a lot because he is independent and not really an analyst – he’s a geologist and good researcher who strays off the beaten path – produced a fascinating little chart recently on his Energy Matters site. The chart showed that conventional oil and condensate – the “black” oil that comes out of the ground easily and relatively cheaply and can be refined into gasoline – reached a production level of 73 million barrels a day in 2005. Guess what? Almost a decade later, conventional oil production has not climbed even though prices were high for most of that time.

What drove global production up to the current 92 million barrels a day or so was non-conventional production – the oil sands, U.S. shale oil, biofuels and natural gas liquids. The problem is that most of this production is highly expensive and a lot of it, like the gas liquids, is refined into heating fuels, such as butane, not transportation fuels, which are the biggest oil products market. Barring a technological breakthrough, the world has probably seen “peak” conventional oil production. That means any significant production gains will have to come from non-conventional oil. Continued low prices can only damage that production.

The e-car revolution isn’t.

To listen to Elon Musk, the Tesla e-car founder, and other locomotion-by-battery cheerleaders, e-cars are set to make huge market inroads after finding themselves parked on the sidelines for a century. If they are right, global oil demand will fall and the price will react accordingly, since cars are the biggest users of oil. And wouldn’t it be nice to see our streets plugged with quiet, clean electric machines instead of cars powered by C02-belching internal combustion engines? The flaw in the vision is that the e-car revolution is nowhere in sight. The U.S. market for e-cars and hybrids – the latter are cars powered by batteries and gasoline engines, like the Toyota Prius – is only about 4 per cent of auto sales. And the market for plug-in electric cars is actually declining. Low oil prices could well keep a tight lid on e-car and hybrid sales as the cost of a fill-up goes from extortionate to a price of a bad family meal.

Busting national budgets.

OPEC has 12 member states and most of them need prices far higher than $70 a barrel to clear their budgets. While some, such as Saudi Arabia, theoretically have the financial flexibility and health (such as low debt-to-GDP ratios and high foreign reserves) to withstand low prices for years, more than a few do not. If low prices persist, they will reach their pain thresholds and demand production cuts to prop up the price.

According to the International Monetary Fund, Deutsche Bank and other sources, At least nine OPEC members need prices north of $75 a barrel to balance their books. The ones that require the highest prices are Iran (about $140), Venezuela, Nigeria and Algeria (about $120 each) and Ecuador (about $117). Saudi Arabia requires $95 oil. Kuwait, United Arab Emirates and Qatar should feel no pain at the current price, which is not to say they like the current price.

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From page A1 Saskatchewan’s economic growth is expected to reach just 1.5 per cent this year, after posting a 5.0 per cent increase in 2013 boosted by a record-breaking crop, according to the Conference Board of Canada.

The province’s economic performance — ranked seventh among the 10 provinces in 2014 — is “in contrast to the robust growth of the early part of this decade,’’ said the Conference Board’s provincial outlook released Thursday.

“While the Saskatchewan economy remains on solid ground, lower yields in the agriculture sector and more temperate gains in the oil industry will cap Saskatchewan’s growth prospects for the near term.”

Fortunately, uranium and potash mining will be “bright spots’’ for the provincial economy during the next two years, the report said.

“Gains in metal mining and potash production will help overall real GDP advance by 2.4 per cent in 2015, although the forecast is muted by lower yields in the agriculture sector and more temperate gains in the oil industry.”

The Ottawa-based economic forecaster said production at the Cameco Corp. Cigar Lake uranium mine in northern Saskatchewan will ramp up as Japan’s nuclear reactors come back on stream in 2015 and demand grows from China and other emerging markets. Potash mining is also expected to rebound in 2015 after the collapse of the Russia-Belarus potash cartel in 2013 caused prices and production to plummet.

Manufacturing will also show steady growth over the next two years, but construction will slow down in 2016 after posting healthy 3.2 per cent growth in 2015. The fall-off in construction activity will dampen the performance of the province’s goods producing sector in 2016, the report said.

Employment is forecast to increase 1.6 per cent in 2015 and 1.2 per cent in 2016.

Unemployment will continue to hover in the four per cent range, which ensures that Saskatchewan will boast the lowest jobless rate in Canada in 2015-16, the report added.

Vast tracts of Saskatchewan farmland have been scooped up by investors from outside the province.

Some rural municipalities have seen a 20-fold increase in corporate land ownership since 1994. Three corporations each now own more than 100,000 acres.

That and other revelations form part of a joint study by researchers at the University of Saskatchewan, University of Regina and University of Manitoba, quantifying the rapid concentration of farmland ownership in the province. “There are huge amounts of land being bought up,” said Saskatchewan native and University of Manitoba professor Annette Desmarais.

“We’re just beginning to understand what the impacts are. It makes it very difficult to build community in that environment.”

The data is scheduled to be presented this morning to delegates at the National Farmers Union (NFU) convention in Saskatoon. The full study is due for publication in the January edition of the Canadian Journal of Food Studies.

Desmarais and the other researchers combed through electronic and paper records at rural municipality offices and other locations. They focused on three RMs in different regions.

In the RMs of Harris, Lajord and Excel, less than 3,200 acres were owned by investors or “farmer/investor hybrids” in 1994. That number has now grown to 59,441.

The change is largely due to amendments made a decade ago to the legislation governing farmland ownership. Previously restricted to Saskatchewan residents, farmland can now be purchased by people living outside the province.

Desmarais and NFU president Jan Slomp said the situation exacerbates the decline of some rural communities. The investors don’t generally live in the areas where they own land, their kids don’t go to the local school, they don’t contribute as much to the local economy, and they aren’t part of the town’s social life.

“It’s absentee exploitation of the land,” Slomp said. “It’s sucking the lifeblood out of our communities.”

They say this “land grab” is making it hard for a new generation of farmers to start their own operations.

The largest landowner listed in the study is Robert Andjelic & Andjelic Land Inc., with Saskatchewan holdings of 161,241 acres.

In an interview Thursday, Andjelic, who hails from Manitoba and now lives in Alberta, said he actually owns about 180,000 acres.

He said Saskatchewan farmland has risen in price since the changes, but it’s still among the most affordable, most productive land in the world.

He said farms must grow to stay competitive and to take advantage of the larger, better machinery. One seeding machine, which used to be six metres wide, is now four times that size.

“We have to be as efficient as we can,” he said.

Andjelic said he partners with young local farmers to produce crops on his land, and provides jobs to others. He said the higher land prices have allowed older farmers to retire comfortably.

“It’s put money in all their pockets,” he said.

Desmarais and Slomp said land concentration is not inevitable.

“It all depends on what legislation you put in place,” Desmarais said.

They point to Prince Edward Island, which restricts farmers to 1,000 acres of land and corporations to 3,000. The rules have been in place since the 1970s, when large potato and french fry companies tried to take control of large amounts of land.

NFU board member and PEI organic farmer Reg Phelan said the rules have allowed family farms to survive. PEI continues to be Canada’s largest potato producer, despite the small average farm size. Phelan said the law has been challenged several times in court, but has remained in place.

“It’s about what type of farming you want to see,” he said.

Desmarais wrote the study with U of R professor Andre Magnan, Saskatchewan researcher Darrin Qualman and Nettie Wiebe, a professor at St. Andrew’s College at the U of S.

The research team is already at work on a followup to provide a more detailed picture of farmland ownership in Saskatchewan.

Oil tumbles below $70 as OPEC holds fire despite collapse in prices

OPEC, the oil cartel responsible for 30 per cent of global oil production, will not cut output in spite of the supply glut, a decision that will put more downward pressure on already tumbling prices.

OPEC’s production ceiling will remain unchanged at 30-million barrels a day, OPEC ministers announced Thursday. OPEC’s secretary general, Abdalla Salem El-Badri, said the quota will remain in place for the first six months of 2015. OPEC next meets in Vienna on June 5.

He said OPEC has no target price and that the member countries are not worried about the near 35-per-cent price plunge since June. “We are not sending any signal to anybody,” he told reporters after the meeting. “We have to wait and see how the market will settle. I have said many times to you we don’t want to panic and we meant it.”

Before the conclusion of the meeting at 4 p.m. European time, the oil markets were selling off rapidly as investors took the view that OPEC would be unable to muster support for a production cut to support sagging prices. Brent crude, the effective international benchmark, fell 3.3 per cent on Thursday, taking the price to just above $75 (U.S.) a barrel. In June, the price was $110.

In light Thanksgiving trading in the U.S., the benchmark North American crude, West Texas Intermediate, fell below the $70 a barrel mark.

The Canadian dollar, at a high point just shy of 90 cents U.S. earlier today, slipped to 88.15 cents.

The TSX energy group tumbled more than 6 per cent, led by a steep selloff of major oil sands producers.

Suncor Energy Inc. fell 6.2 per cent, Canadian Natural Resources Ltd. was down about 7 per cent and Cenovus Energy Inc. was off about 5 per cent.

Talisman Energy Inc., which has struggled to sell assets amid oil’s slide, fell roughly 5.3 per cent, and Penn West Petroleum Ltd. was down nearly 14 per cent. Encana Corp., which has spent billions on oil properties, was down about 5 per cent.

The decision to keep OPEC’s 30-million barrel a day production target intact did not please all OPEC member states. Venezuela had planned to push for a production cut as it watches is foreign currency reserves fall away. As the oil ministers met, Venezuelan oil minister Rafael Ramirez said, “Everone has to make some sacrifice.

A month ago, Mr. Ramirez said that $100 a barrel was a fair price.

A price that high seems unreachable in the near term, in good part because non-OPEC oil supplies are soaring, thanks in good part to America shale oil output. In the United States, shale oil production is rising every six months b about 500,000 barrels a day.

OPEC said that oil demand will actually rise next year, in spite of slowing growth in China and almost not growth in Europe, by 1.1-milion barrels a day to 92.3-million barrels. But supply is increasing at a faster pace, with non-OPEC supply expected to increase by 1.4-million barrels a day in 2015, to 57.3-million barrels a day.

“The market is oversupplied,” said United Arab Emirates Energy Minister Suhail Al-Mazrouei. “But the oversupply is not from OPEC.”

Analysts said the surging non-OPEC supply signals that OPEC is losing control of the market.

“The balance of power has shifted and OPEC is accepting the fact that its ability to control the long-term price of oil is limited,” said Michael Hewson, a market analyst at London’s CMC Markets, said just before OPEC’s production quota was confirmed.

As crude prices have fallen, pump prices followed suit and are now the lowest in four years. On the Prairies, regular gasoline is already selling below $1 a litre at many stations, while they have hit $1.07 in areas of Toronto, according to gasbuddy.com, an online survey site.

Gasbuddy.com analyst Dan McTeague said if crude prices fall below $70 (U.S.) a barrel as many analysts expect as a result of the OPEC decision, pump prices will dip below $1 in many Canadian cities.

As a significant oil producer, the Canadian economy will be hurt by the lower prices, but the pain will be felt primarily in Western Canada and Newfoundland and Labrador, while consuming provinces may welcome the lower pump prices and manufacturers will benefit from a devalued loonie.

However, the federal government is warning its revenues will decline by as much as $2.5-billion a year in the coming years if oil prices remain at depressed levels.

The impact “depends on how long (the lower prices) are sustained,” said Paul Ashworth, economist with Capital Economics in Toronto. OPEC “hasn’t cracked at the moment but there is the possibility that at some point in the future, if prices remain low, they will crack.”

Mr. Ashworth said most existing production in Canada will be maintained – and will even be profitable – below $70 a barrel, but new investment in oil sands projects will be undermined.

“It does present a downside risk to marginal projects that we could have seen in the future,” he said. The highest cost projects aren’t going to get the go-ahead if these prices are maintained.”

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BUDGET REMAINS ON TRACK DESPITE DROP IN OIL PRICE

Released on November 27, 2014

Lower Oil Price Could Have More Impact on Next Year’s Budget

Saskatchewan remains on track to post a balanced budget in 2014-15. The Mid-Year Report released today projects a year-end surplus of $70.9 million.
“While the price of oil has fallen in recent weeks, it remained high for the first few months of the fiscal year, so overall, resource revenues are still projected to be ahead of budget this year,” Finance Minister Ken Krawetz said. “However, it now looks like we will start the 2015-16 Budget year with a lower oil price, which means our government will need to carefully manage spending.”
Krawetz said the Saskatchewan economy remains strong despite the impact of falling oil prices on government revenues.
“Right now, Saskatchewan has the strongest job growth and lowest unemployment rate in Canada,” Krawetz said. “Most of the new jobs are not in the resource sector. They are in other areas, which shows the importance of a strong, diversified economy.”
Total revenue for 2014-15 is now projected at $14.199 billion, up $126.4 million from budget.
Projected revenue from non-renewable resources is up $59.5 million from budget. Higher potash revenue and Crown land sales more than offset the projected revenue decrease in oil.
Net income from Crown Corporations and other Government Business Enterprises including the insurance sector is up $183.8 million from budget, while revenue from taxation, personal income tax, corporate income tax and tobacco is $145.3 million lower than expected at budget.
Total expense for 2014-15 is now projected at $14.129 billion, up $126.9 million from budget. Much of this increase, about $107 million, is attributable to projected costs related to disaster assistance for those affected by recent flooding.
“Our government will continue working hard to keep Saskatchewan’s economy and its finances strong,” Krawetz said.
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For more information, contact:
Jeff Welke Finance Regina Phone: 306-787-6046 Email: jeff.welke@gov.sk.ca Cell: 306-536-1185

Saudi Oil Minister Ali al-Naimi told reporters on Thursday that OPEC will not cut its oil output.“That is right,” Naimi told reporters in response to a question on whether OPEC had decided not to cut oil supplies.

He was speaking after a five hour meeting of the producer group broke up.